2015

37

3. Managing government financesIn 2010, the Coalition promised to eliminate the budget deficit – the gap between government spending and revenue – largely through controlling public spending.1 Five years later, progress has been made: the deficit has fallen and the Government has said it will run a budget surplus in 2019/20.2

Government revenue is drawn from various forms of taxation, fees for services, and public sector borrowing. The composition of these has shifted slightly since 2010, with a higher proportion coming from central government taxation in 2013/14.

This money is shared out among departments. How much each receives varies, from DWP (£175.4bn) to HMT (£200m). Departments also differ in the balance between:

• Annually Managed Expenditure (AME) – demand-led spending, such as pensions and benefits – and defined Departmental Expenditure Limits (DEL). DWP and HMRC are dominated by AME; most others by DEL

• spending on resource (day-to-day running costs of government programmes and administering the department) and capital (investment in assets). DfT and BIS have most capital spending

• the size of their assets (HMT, MoD and DfT having the most) and liabilities (DECC and DH, increased since 2010)

• the reductions to budgets since 2010, with DCLG experiencing the deepest cut to its resource DEL.

Despite the Coalition’s commitment to improving the transparency of public spending data and creating ‘an army of armchair auditors’, it is still difficult – and in some cases impossible – to identify why departmental budgets have changed and where savings have been made. Changes in spending plans are reported in financial documents but are not always fully explained. When each department is rated according to how clearly it has accounted for changes in its budgets since the 2010 Spending Review, HMT and HMRC come bottom (as they did in Whitehall Monitor 2014). Parliament could, and should, play a greater role in holding departments to account for unexplained changes in spending plans.

About the data

The Whole of Government Accounts (WGA) give us the financial picture across government. These are consolidated financial accounts of the whole public sector. We also used the Office for Budget Responsibility’s public finances databank as of October 2015.3

We use Public Expenditure Statistical Analyses (PESA) to analyse total managed expenditure. PESA is published by the Treasury every year in July. It contains outturn and forecast figures for a large number of spending control totals.4

For more detail on government departments, we have used the departmental Annual Reports and Accounts. These are published annually by each department and contain consolidated financial statements for the departmental group.5

In our work on financial transparency we use Spending Reviews and annual Budgets. These set out the planned expenditure for each department for successive financial years.6

Get the latest data www.instituteforgovernment.org.uk/finances

38

INSTITUTE FOR GOVERNMENT

Public sector spending has increased by 7% since 2010, while public sector borrowing has fallen. Revenue from direct taxation has risen, but so have net liabilities.

Net Borrowing Total Expenditure Receipts

£154bn£135bn £114bn £120bn £100bn

£90bn£688bn

£708bn £708bn £722bn £725bn £738bn

£534bn£573bn

£594bn £602bn£625bn

£648bn

£0bn

£100bn

£200bn

£300bn

£400bn

£500bn

£600bn

£700bn

£800bn

2009/10 2010/11 2011/12 2012/13 2013/14 2014/15

Public sector spending in 2014/15 was £738bn, £90bn more than the £648bn raised through taxation and other forms of revenue. This shortfall between revenue and expenditure – public sector net borrowing – has fallen consistently since 2010, from 22% of total expenditure to 12% in 2014/15.

Central govtgoods & services

Public corporations

goods and services

Local govt goods and

services

Other revenue

Local govt taxes

Indirect Taxes

2010 2014 2010 2014 2010 2014 2010 2014 2010 2014 2010 2014 2010 2014

£300bn

£200bn

£100bn

£0bn

Direct taxes

The bulk – £308.9bn, or 48% – of government revenue came from direct taxes, including income tax, National Insurance contributions and corporation tax. Indirect taxes, which include value added tax, excise duty and stamp duty, amounted to £194bn. The proportion of income generated through taxation in 2013/14 was 78%, an increase of four percentage points since 2010. While revenue from indirect and direct taxation has increased since 2010, the former has increased more substantially: from £148bn in 2009/10 to £194bn in 2013/14.

39

3. managing governmenT financeS

Government also generates revenue through the sale of goods and services. This is higher at local than at central government level. For local government, this revenue stream includes fees for public services – such as social care, leisure facilities, environmental services and transport.

Departments receive income from goods and services they provide through their operations (income from central government services was £4.7bn in 2013/14, or 0.5% of all revenue raised). The largest single source of this income is the Nuclear Decommissioning Authority (£900m in 2013/14), which receives fees for waste management and electricity generation contracts.7

Government also receives income from the sale of goods and services by public corporations. The amount gained from this revenue stream fell over the past five years from £16.1bn in 2009/10 to £10.5bn in 2014/15. This is mainly due to the sale of public corporations such as the Tote in June 2011 and the postal service in 2013.8

£1.23tn£1.19tn£1.35tn£1.57tn£1.80tn

£2.48tn£2.42tn£2.62tn£2.91tn£3.18tn

£1.25tn£1.23tn£1.27tn£1.34tn£1.38tn£0.0tn£0.5tn£1.0tn£1.5tn£2.0tn£2.5tn£3.0tn£3.5tn

2009/10

Net liability Total Liabilities Total Assets

£1.23tn £1.19tn£1.35tn

£1.57tn£1.80tn

£2.48tn £2.42tn£2.62tn

£2.91tn

£3.18tn

£1.25tn £1.23tn £1.27tn £1.34tn £1.38tn

£0.0tn

£0.5tn

£1.0tn

£1.5tn

£2.0tn

£2.5tn

£3.0tn

£3.5tn

2009/10 2010/11 2011/12 2012/13 2013/14

Revenue and expenditure streams are not the only financial resources that government must manage. It also oversees a large portfolio of financial assets and liabilities, which dwarfs annual income and expenditure. At the whole-of-government level, assets amounted to £1.38tn in 2013/14. This is made up chiefly of property, plant and equipment (£726bn), such as buildings and roads. Government also holds financial assets in the form of loans and deposits with banks (£147.8bn), student loans (£39bn) and equity investments (£66.6bn).

On the other side of the Government’s balance sheet are its liabilities. In 2013/14, these amounted to £3.176tn, of which the largest components were obligations for public sector workers’ pensions (£1.3tn) and government financing and borrowing – the public debt (£1tn).

When people talk of ‘paying down the debt’ and ‘balancing the books’, it is usually in terms of reducing spending and raising revenue – assets and liabilities are rarely mentioned, though they make up a much larger slice of the Government’s financial resources. As the new Government continues to reduce the deficit and pay down public debt, more attention might be given to how its balance sheet can be managed to achieve its financial goals. This should involve reducing liabilities as well as sensible management of public assets.

40

INSTITUTE FOR GOVERNMENT

Government spending is not shared equally between departments: DWP and DH accounted for 50% of all departmental spending in 2014/15.

DWP£175.4bn

DH£117.9bn

DfE£59.6bn

HMRC£47.1bn

MoD£35.5bn

DCLG£33.8bn

DECC£32.9bn

BIS£26.5bn

DfT£19.8bn HO

£12.3bn

DfID£10.2bn

MoJ£7.1bn

DCMS£7.0bn

Defra£2.3bn

FCO£1.7bn

CO£0.7bn

HMT£0.2bn

While some resource is used to service public debt and pension liabilities, the majority of the Government’s expenditure – £576bn in 2014/15 – is allocated to government departments.9 Of this, 50% went to the two largest: DWP and DH, which each have a budget in excess of £100bn (£175.4bn for DWP, £117.9 for DH). DfE (£59.6bn) is the only other department with a budget greater than £50bn. This spending covers all the programmes for which these departments are responsible – the majority of DH’s total managed expenditure is spent on the NHS, while the majority of DfE’s expenditure is spent on schools – as well as the costs of running the department.

At £32.9bn, DECC’s planned total managed expenditure was significantly higher in 2014/15 than 2013/14 (£3.9bn). This increase is due to the allocation of £28.8bn to DECC to cover provision for liabilities incurred under Contracts for Difference, funds payable to low-carbon electricity generators to make up the difference between the cost of investing in technology and the market price for electricity in the UK.10 This liability will be funded by electricity consumers rather than government.11

Mid-sized departments, with budgets ranging from £10bn to £50bn, include HMRC, MoD and DCLG. Compared with these, FCO, CO and HMT – with budgets of less than £2bn – appear tiny.

41

3. managing governmenT financeS

Departmental budgets are split into different kinds of spending.

Department Expenditure Limits

Planned spending – limits set for multi-year periods

Annually Managed Expenditure

Demand-led spending (e.g pensions, benefits)

Resource DEL (RDEL)DEL (RDEL)DEL (RDEL)DEL (RDEL)43%

Capital DEL (CDEL)6%

Administration1%

Programme42%

Resource AME (RAME)46%

Dept AME34%

Other AME11%

Capital AME (CAME)3%

Capital Dept AME1%

Capital Other AME2%

49% 51%

89%

9%

Capital

Investment and maintenance of assets (e.g. roads, buildings)

Resource

Day-to-day running costs (e.g staff costs, policy spend)

As part of the strict processes and controls applying to how and where departments can spend their money, a department’s spending allocation for each financial year – its total managed expenditure (TME) – is broken down into different categories, each of which can be used only for particular kinds of spending.12

At the top level, departmental budgets are split between:

• Departmental Expenditure Limits (DEL) This represents a relatively known quantity, covering plans that departments are committed to: the spending that departmental leaders can allocate to meet their objectives, as announced at Spending Reviews. DEL budgets are often set for a multi-year period, with minor adjustments made within the annual reporting cycle. DEL spending is limited, meaning departmental leaders cannot overshoot their allocated DEL budget – although they can underspend.

• Annually Managed Expenditure (AME) A spending line is defined as AME spending if it ‘cannot reasonably be subject to firm three-year limits’ (it is harder to predict, unlike DEL spending, which is set at Spending Reviews). This may be because it relates to functions that are demand-driven, such as pensions or welfare payments, or student loans.13

42

INSTITUTE FOR GOVERNMENT

DWP and HMRC are dominated by demand-led spending, while DfE, CO and Defra spending is 100% DEL.

0%

25%

50%

75%

100%

DWP HMRC DECC DCMS BIS DfT HMT HO MoD DH DfID DCLG MoJ FCO DfE CO Defra

AMEAMEAMEAME DELDELDELDEL

The proportion of DEL and AME varies according to each department’s policy responsibilities and functions.14 The majority of DWP and HMRC’s spending is categorised as AME because they are responsible for policy areas that are demand-led, such as pensions and welfare. DECC’s AME spending is largely comprised of funding for Contracts for Difference.15 DCMS’s AME spending includes expenditure funded from the proceeds of the National Lottery (National Lottery grants), and expenditure of the BBC.16 Other departmental budgets – such as DfE, CO and Defra – are almost entirely categorised as DEL.

�������

AMEDEL

DECC

CO DfE

DH DCLG

BISDWP HMRC

HO

Whole Govt

FCO

DCMS

HMT

Defra

MoD

100%

50%

0%

MoJ

DfT

2010 2015 2010 2015 2010 2015 2010 2015 2010 2015

100%

50%

0%

100%

50%

0%

In 2014/15, AME spending overtook DEL spending across the whole of government. AME comprised 47% of total managed expenditure in 2010/11 – by 2014/15 this had increased to 51%.17 However, if we exclude the £28.8bn allocated to DECC in 2014/15 to cover the cost of Contracts for Difference, then DEL remains the larger of the two categories, accounting for 51% of total managed expenditure in 2014/15.

43

3. managing governmenT financeS

The balance of spending in most departments changed little over the course of the last Government, with the exception of DfT and BIS. DfT saw a sharp increase in its (capital) AME spending from just 1% of total departmental expenditure in 2010/11 to 36% in 2014/15. This is in part the result of Network Rail being reclassified to the public sector from September 2014. The main consequence of this change is to bring Network Rail’s debt on to the public balance sheet.18 Network Rail accounted for £6.5bn in capital AME spending in 2014/15.

BIS has also seen an increase in AME spend over the past five years, partly due to a reduction in DEL spending, as well as an increase in spending on student loans.

DfT, BIS have significant capital spending, which has increased since 2010; HMRC, DWP have a much smaller proportion.

0%

25%

50%

75%

100%

DfT BIS Defra DfID DCLG MoD DCMS DfE DECC HMT FCO MoJ DH HO CO HMRC DWP

Capital Resource

The other major division within total managed expenditure is between:

• Resource spending This covers the department’s day-to-day operations, and is further divided into administration spending, which covers departmental running costs including staff salaries and accommodation, and programme spending, which pays for policies and programmes.

• Capital spending This adds to the public sector’s fixed assets, such as transport infrastructure and public buildings. Funds earmarked for capital spending cannot be transferred to resource spending. This ring-fencing is intended to ensure that sufficient funds are invested in public sector assets, which provide longer-term returns.

As with DEL/AME spending, the proportion of a department’s total budget categorised as capital or resource spending depends on the nature of its policy functions and responsibilities. DfT and BIS have the highest proportion of spend allocated to capital budgets. Much of DfT’s capital budget goes on maintenance of an investment in the UK’s transport infrastructure: its capital budget for 2013/14 includes £3.7bn of spending on Network Rail, £1.1bn on Crossrail and £1.9bn on the Highways Agency. BIS capital spending includes spending on higher education (£10.3bn), including investment in higher education institutions.

44

INSTITUTE FOR GOVERNMENT

Capital

Resource

DCMS

HMT DECC

CO

MoD

Whole Govt

DWPHMRCHO

FCO

DCLGDefraDfT

MoJDfE

DH

BIS100%

50%

0%

100%

50%

0%

100%

50%

0%

2010 2015 2010 2015 2010 2015 2010 2015 2010 2015

Over the course of the last parliament the split between capital and resource spending at a whole-of-government level remained unchanged, with resource spending making up 90% of the total.19 However, for some departments the balance has shifted. As noted above, DfT has seen an increase in capital spending, in large part due to the reclassification of Network Rail. DECC has shifted in the other direction. In 2010/11 DECC’s capital budget was 23% of total expenditure; in 2014/15 it had fallen to 7%. While the department’s capital budget has in fact grown since 2010/11, this rebalancing is due to a significant increase in DECC’s resource AME budget. In 2014, the department was allocated £28.8bn as provision for Contracts for Difference, which support the production of low-carbon energy in the UK.20

HMT, MoD and DfT have the most valuable assets – DECC has a large liability portfolio.

HMT MoD DfT DH BIS DfE DCMS MoJ DfID DWP DECC Defra HMRC DCLG FCO HO£200bn

£150bn

£100bn

£50bn

£0bn

£150bn

£100bn

£50bn

£0bn

Liabilities

Assets

2009/10 2013/14

45

3. managing governmenT financeS

Departments vary widely in the size of their assets and liabilities and the balance between them.21 On the asset side, the Treasury, MoD, DfT and DH stand out. The Treasury’s balance sheet reflects the large stakes that the state took in private sector banks in the wake of the financial crisis; MoD holds the military estate and the stock of weapons systems and ammunition; DfT manages a large part of the road network; and DH controls a large property portfolio.

HMT and DfE have seen the biggest increases in assets since 2010. HMT’s assets increased in 2012/13 before falling back in 2013/14. This is largely due to the change in the value of assets held by the Bank of England Asset Purchase Facility Fund, which were valued at £44.3bn in 2012/13 and fell to £200m in 2013/14.22

The significant change in the size of the DfE asset portfolio reflects the inclusion of academies’ estates in DfE accounts from 2012/13 onwards.

Some assets are not included as the Treasury did not think they could be accurately valued. For example, DCMS does not include assets such as artworks in the galleries it sponsors or in the Crown Estate.

DECC and DH hold the largest liabilities. The bulk of DECC’s liabilities arise from the Government’s obligation to cover the cost of decommissioning nuclear power plants (£70bn), while about half of the DH liability is made up of provisions for NHS clinical negligence claims (£25.7bn). These departments’ liabilities have both increased since 2010.

Budget reductions have varied between departments, with some hit harder than others.

DfID CO NHS DfE

MoD HO MoJ FCO

BIS Defra DWP DCLG DfT

50%

0%

-50%

DECC

DCMS

2010 2015 2010 2015 2010 2015 2010 2015 2010 2015

50%

0%

-50%

50%

0%

-50%

While total government expenditure has risen since 2010, the majority of departments have had their resource DEL budgets (RDEL) reduced over the past five years.23 RDEL is the budget that departments allocate to running policy programmes, set in advance and for multi-year periods. The NHS, schools and international aid budgets have been ring-fenced and so the departments responsible for these spending areas (DH, DfE and DfID) have seen their budgets increase every year since 2010.

While budgets have increased consistently year-on-year in some departments, in others the picture is mixed: DECC’s budget, for example, fell between 2011/12 and 2012/13, only to increase due to various policy changes, the largest being an additional £300m to fund the Government’s Energy Discount. Similarly, there was a sharp increase in the DCMS budget around the time of the 2012 London Olympics, followed by reductions, then a small increase in 2014/15.

46

INSTITUTE FOR GOVERNMENT

Some departments have had their RDEL allocations reduced every year since 2010. The FCO’s RDEL for 2014/15 is 18% less than its budget in 2010/11; DCLG’s is down 44%. The greatest cut in RDEL allocation has been at DfT – its budget for 2014/15 is 51% less than the equivalent figure in 2010/11. However, not all of these decreases in spending are the result of cuts to policy programmes. In 2013/14 DCLG’s budget fell by more than £7bn as a result of changes to local government funding and business rates; in this instance spending was not cut, but was transferred from the department to local government.24 Spending plans for previous years were not adjusted to take this into account. Similarly, the reduction to DfT’s budget between 2013/14 and 2014/15 is due to an accounting change: £900m of transport grants was switched from RDEL to capital DEL.25

The next five years pose challenges for the Government if it is to meet its spending reduction targets. Some of these are self-imposed: for example, if some policy areas continue to be ring-fenced then departments that have already had their budgets reduced will come under mounting pressure to find savings.

Other challenges are external and harder to mitigate. Demographic pressures such as an ageing population will drive demand for health services, pensions and other benefits. An increase in spending in these areas may lead to a further squeeze on others.

Departmental spending plans can change for reasons including machinery of government changes or underspends.

DfT

DCLG

DfID

DWPDefra

DfE DH

BIS MoJMoD CO

DCMS

DECCHO FCO

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

The Coalition set itself the target of reducing the deficit by cutting spending.26 Much of this reduction was accomplished by reducing departmental budgets. As we have seen, the majority of departments had their RDEL budgets cut year-on-year under the last Government.

But this was not the Coalition’s only objective in terms of public finances. It also committed itself to throwing open the books and allowing ‘armchair auditors’ to access government financial data – ‘the money it spends, where it spends it, the results it achieves’.27 Anyone looking back on the Coalition’s record would find it (relatively) easy to identify what money the Government spent – but would have a harder time trying to identify exactly where it spent it.

Like its predecessor, the Coalition Government used Spending Reviews (in 2010 and 2013) to set multi-year departmental budgets. More detailed spending controls are set each financial year through the Budget process, at which spending plans may be revised upwards or downwards. Final outturn figures can differ substantially from the figure set out at Spending Review 2010. In some cases this is due to significant machinery-of-government changes – the 43% increase in Home Office spending is partly the result of the transfer of police grants to the department from DCLG. Similarly, the fall of 40% in DfT’s

47

3. managing governmenT financeS

budget from what was set out in 2010 is partly explained by a transfer of grants from the department to DCLG.28 Other changes may be due to policy changes, underspends, or allocations from the Reserve (funding not allocated to departmental programmes and used to cover ‘emergencies and genuinely unforeseen circumstances’).29 In some cases the reasons for these changes are given in full, either in the document where they appear or elsewhere; in other cases, the explanation is much harder to find.

Departments vary in how clearly they explain changes in their spending plans, with HMT and HMRC performing poorly.

DeptDeptDeptDept 2011/122011/122011/122011/12 2012/132012/132012/132012/13 2013/142013/142013/142013/14 2014/152014/152014/152014/15 2015/162015/162015/162015/16 Overall RankingOverall RankingOverall RankingOverall RankingDCMS 1 DECC 2 DH 3 FCO 4 MoJ 5=DfT 5=BIS 6 DfID 7 DfE 8 HO 9 DWP 10 CO 11=DCLG 11=Defra 12 MoD 13 HMT 14=HMRC 14=

By comparing the original figure set out at Spending Review with subsequent figures produced at Budgets, and the final outturn figure published in the department’s Annual Report, we can chart changes in departmental spending plans across time. We should also be able to identify why those changes occurred and where any additional spending was allocated (or where cuts were made). However, while changes in departmental budgets are easily tracked through fiscal publications, the reasons for those changes are far harder to locate.

We graded each department according to how transparently it accounted for movements in spending plans. For each financial year we compared the original spending plan, as published in Spending Review 2010, with every revised plan for that year (published in annual Budget documents, PESA and the department’s Annual Report and Accounts), and noted whether the spending plan had changed and whether this was explained. We graded each department according to:

• whether an explanation was given for a change

• whether each movement was fully or partially explained

• where the explanation appeared.

We then ranked the departments based on their average transparency rating.

No department provided a full explanation for all movements in the same document in which those movements appear. DCMS ranks highest on our transparency index, as the department had very few changes in forward spending plans and we were able to find an explanation for these, although this was published in a separate document. DH and FCO also score highly because we were able to find full explanations for the spending changes in these departments.

48

INSTITUTE FOR GOVERNMENT

At the other end of the scale are HMRC and HMT. These departments have the lowest transparency scores because of inconsistencies in the way spending is reported. In the annual Budget documentation, funding allocated to both HMT and HMRC is combined under spending plans for ‘Chancellor’s Departments’; at Spending Reviews and in Annual Reports and Accounts, however, separate figures are reported for HMT and HMRC. It is therefore not possible to compare HMT spending, excluding HMRC, across different fiscal documents.

MoD also scores poorly, particularly in providing explanations for recent budget changes. From Spending Review 2013 to the July 2015 Budget, three different spending totals for this department were published – at Budget 2014 (£23.6bn), March 2015 (£28.4bn) and July 2015 (£28.1bn). But the documentation provides no clear explanation for any of these changes. MoD also performed poorly because, as with HMT and HMRC, it does not publish RDEL depreciation figures in its Annual Reports, which makes it impossible to compare outturn with the original spending plan in Spending Review 2010.

We invited departments to provide information on the changes we could not explain. Of the 17 departments we contacted, nine responded with additional information. In some cases we were able to find further explanations for changes in Main and Supplementary Estimates Memoranda which are produced for parliamentary select committees each year. However, the value of these Memoranda as a tool for transparency is limited, as they can be difficult to find: they are published by select committees and not by the department (with the exception of DECC, which provides a link to these useful documents on its departmental website).

Other departments did not respond to our request for additional explanations. Among them was the Treasury, which is at the bottom of our transparency table for the second year in a row. When contacted, officials seemed unconcerned that we could not explain movements in their departmental spending over the last parliament, and offered no explanation. As the department responsible for producing Spending Reviews and annual Budgets – the documents where changes to planned departmental budgets often appear – the Treasury should offer a clear explanation for changes to its own spending totals.

The Coalition made considerable progress in reforming the public finances in line with its pledges in the Coalition Agreement. The current deficit has shrunk and departmental expenditure has fallen, apart from in those departments where spending was ring-fenced. But other trends point to trouble ahead. The Government’s net liabilities have increased since 2010, with the value of government assets growing slowly compared with the value of its liabilities. Securing further spending reductions may also prove challenging as demographic pressures increase demand on health and social care services, potentially leading to a squeeze on other spending areas. However, both the successes of the past five years and the challenges that remain are hard to assess given the lack of transparent data available. David Cameron’s army of armchair auditors could find itself lost in the no-man’s-land of the partially or wholly unexplained.